'What makes Charlie Munger a great investor?'

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Charlie Munger posed a puzzle of sorts to an audience during an informal talk in July 1996.

Imagine yourself in Atlanta in 1884. A bunch of you are brought before a rich and eccentric citizen named Glotz. You have to present a business plan to start a business that will turn a $2 million investment to $2 trillion by the year 2034. The new venture must be named Coca-Cola and it must exclusively sell non-alcohol beverages.

You have 15 minutes to make your pitch to Glotz.

What followed was a provoking and startling display of business acumen. Munger laterally presented seemingly non-related issues by delving into a deep repository of knowledge and stunningly brought it all together.

He started off with some basic common sense, which he called "no-brainers".

"We are never going to create something worth $2 trillion by selling some generic beverage. The refore, we must make your name, “Coca-Cola,” into a strong, legally protected trademark.

We can get to $2 trillion only by starting in Atlanta, then succeeding in the rest of the United States, then rapidly succeeding with our new beverage all over the world. This will require developing a product having universal appeal because it harnesses powerful elemental forces."

He then quoted Aristotle, referred to the biblical Ten Commandments, touched upon Darwinian evolution, and went into some detail regarding Pavlovian effects. By combining math, psychology, sociology, and thinking through the problem in reverse, he conveyed the importance of using multi-disciplinary knowledge to make better decisions.

Little wonder that Bill Gates is known to have commented that Munger is truly the broadest thinker he has ever encountered.

Munger is voracious reader who does not box himself into believing that learnings from one discipline cannot be implemented in another. In fact, he believes that it makes him a much more rational thinker.

"When I urge a multidisciplinary approach- that you’ve got to have the main models from from a broad array of disciplines and you’ve got to use them all – I’m really asking you to ignore jurisdictional boundaries. If you want to be a good thinker, you must develop a mind that can jump these boundaries.

You don’t have to know it all. Just take in the best big ideas from all these disciplines. And it’s not that hard to do."

Robert Goldsborough, fund analyst on the passive funds research team of Morningstar, explains it in terms of Munger’s investment process.

One of Munger's principal frameworks is to more broadly understand, collect, and organise the factors affecting an investment candidate. This means drawing what he calls "multiple mental models" from a variety of disciplines, including engineering, mathematics, physics, chemistry, and psychology.

Driving this need to understand the various dynamics surrounding an investment--both in its internal and external environment--is Munger's understanding that these various factors can work in concert. Munger termed that dynamic a "Lollapalooza Effect"--when anywhere from two to four forces all are driving the investment in the same direction. And yet, Munger noted in Outstanding Investor Digest in 1997 that the effect isn't "simple addition" but rather more akin to a "nuclear explosion."

One doesn't need to be an academic to tap these different models, including the modern Darwinian synthesis model from biology or cognitive misjudgment models from psychology. Indeed, Munger himself acknowledges that his understanding of these models is entirely self-taught.

Munger's invocation of multiple mental models has given him having a mindset characterised by four guiding principles that any ordinary investor should follow: Preparation, Patience, Discipline, and Objectivity.

When practiced correctly, these attributes should result in buying great businesses at good prices and keeping one's portfolio turnover low. As Munger himself once said, "You're paying less to brokers, you're listening to less nonsense, and if it works, the tax system gives you an extra 1, 2, or 3 percentage points per annum."

Can anyone else follow Munger's mindset?

Poor Charlie's Almanack describes his worldview, perhaps tongue-in-cheek, as "Quickly eliminate the big universe of what not to do, follow up with a fluent, multidisciplinary attack on what remains, then act decisively when, and only when, the right circumstances appear." As Munger and Buffett have proven, it works.

It's kind of fun to sit there and outthink people who are way smarter than you are because you've trained yourself to be more objective and more multidisciplinary. Furthermore, there is a lot of money in it, as I can testify from my own personal experience."

Munger holds the view that he should stick to his knitting when evaluating investment candidates. "Yes" candidates are easy-to-understand businesses with distinct and sustainable competitive advantages with a dominant franchise. He immediately dismisses other possibilities, especially in health care and technology, into what he calls the "too tough to understand" pile and others--deals pushed by brokers, including IPOs--into the "no" pile.

"Every person is going to have a circle of competence. If I had to make my living as a musician… I can’t even think of a level low enough to describe where I would be sorted out to if music were the measuring standard of the civilization. You have to figure out where you’ve got an edge. Warren and I don’t feel like we have any great advantage in the high-tech sector. In fact, we feel like we’re at a big disadvantage in trying to understand the nature of technical developments in software or computer chips. So we tend to avoid that stuff, based on our personal inadequacies."

Within his circle of competence, Munger considers every aspect of a business when considering a candidate for investment, evaluating management’s character and capital allocation decision-making. He also analyses a business' competitive advantages, mindful that few businesses endure for multiple generations. Thus, understanding a business' sustainable competitive advantages is critical.

Munger pays close attention to the company's operating and regulatory environment, the impact on it from changes in technology, hidden exposures, and the current and future impacts of stock options, pension plans, and retiree medical benefits.

Finally, when attempting to compute the business' underlying value, to avoid anchoring, he tries to calculate a business' value independently of the price at which a company trades.

When he does narrow down on a potential winner, he goes all the way. He seldom bets, but bets big.

"It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it – who look and sift the world for a mispriced bet – that they can occasionally find one. And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. If you look at Berkshire Hathaway and all of its accumulated billions, the top 10 insights account for most of it. I don’t mean to say that Warren only had 10 insights. I’m just saying that most of the money came from 10 insights."